New CFPB rules crack down on irresponsible mortgage lending

The Consumer Financial Protection Bureau (CFPB) released rules today designed to prevent mortgage lenders from making risky, unaffordable loans. These ability-to-repay rules require that lenders document and verify information demonstrating that a borrower can afford a loan and define a class of mortgages, called Qualified Mortgages (QM), that are presumed to comply with the ability-to-repay rules.

“The housing crisis was triggered by mortgages that were designed to fail—lenders put borrowers into exotic, costly loans that didn’t require proof that borrowers could actually afford them,” said Dory Rand, president of Woodstock Institute. “The CFPB’s ability-to-repay rules go a long way towards preventing the abuses that led to the foreclosure crisis, the collapse of our economy, and the destruction of billions of dollars of wealth, especially in low-wealth communities and communities of color. The QM rules set clear standards for a fair playing field that will reduce uncertainty for both borrowers and lenders.”

The ability-to-repay rules contain a number of provisions with which lenders must comply to ensure that borrowers have the means to afford their mortgages. Lenders must document the borrower’s employment status, income and assets, debt, credit history, and other factors that demonstrate ability to repay the loan. Using this information, lenders must determine that the borrower can afford the loan, using clearly defined standards such as the borrower’s debt-to-income ratio. The ability to repay can’t be based on low teaser rates, either: lenders must calculate the borrower’s ability-to-repay given the highest interest rate the loan can reach in the first five years.

The rules define Qualified Mortgages as loans with fewer risky characteristics, and for those loans, the lender will be presumed to have complied with the ability-to-repay rules. The qualified mortgage definition incentivizes safe and sustainable mortgage lending by providing some protections from lawsuits to lenders in exchange for offering affordable, soundly structured loan terms. In order to meet the qualified mortgage requirements, loans must:• Be affordable: Mortgage payments plus the borrower’s other debt obligations cannot exceed 43 percent of their monthly income.• Lack excessive fees: Lenders won’t be able to nickel-and-dime borrowers with exorbitant fees. Generally, QM loans cannot have fees and points that exceed three percent of the total loan amount.• Lack risky features: QM loans cannot include exotic features, such as interest-only payments, loan terms longer than 30 years, and principal balances that increase over time, that raise the risk of foreclosure and contribute to negative equity.

The CFPB decided upon a tiered approach to protecting lenders offering QM loans from lawsuits. Borrowers would be able to challenge the underwriting of QM loans that have higher interest rates, while borrowers would have fewer ways to challenge prime QM loans. While we would prefer that all borrowers could challenge lenders that failed to assess their ability to repay, the tiered approach ensures that there are strong consumer protections in the subprime market that saw significant abuses in the past.

Woodstock is concerned that, under the current rules, lenders would be able to incentivize higher-cost loans by paying their brokers bonuses for putting borrowers in mortgages with higher interest rates. The CFPB should close the loophole allowing for these yield-spread premiums that encourage lenders to put homeowners in more expensive loans.

“The CFPB designed the qualified mortgage rules to offer the strongest consumer protections for the riskiest loans and more protection for lenders who make the most affordable, safest loans,” said Rand. “This provides sufficient incentives to lenders to make loans that people can afford while ensuring that borrowers have some recourse against lenders who break the rules. Woodstock will continue to advocate for policies that promote access to safe credit in low-wealth communities and communities of color.”